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Western work will return if East is overused

Kumar Gautam, 17 April 2004

If demand for Indian IT workers leads to a drop in service quality, many businesses - already under attack for fuelling job losses - may be forced to close operations there.

Media attention over jobs moving to India, China, Mexico and elsewhere is mainly due to the stunted job market in the US where over two-and-half-million jobs have been lost since 2000. The US economy has seen the strongest growth in 20 years in the second half of 2003: GDP growth of over eight per cent in the third quarter and over four per cent in the fourth quarter. And yet few new jobs are being created to offset the job losses and to absorb the number of young people entering the labour force.

This jobless economic recovery is providing potent fuel to the Democrats in their campaign to defeat the Republicans in the November presidential and congressional elections. The mass media, which for the past three years generally gave President George W Bush's administration easy coverage, is now more critical, mainly by just reporting what the Democrats have to say, including on the key issue of job losses.

In addition, unlike the blue collar jobs going to Mexico and China, the jobs sent to India are white collar and professional jobs. People in such jobs are more visible, vocal and better organised as lobbying groups. They are also relatives, friends and neighbours of those working in the media. Hence the issue of American jobs going to India getting wider and more critical media attention by the day.

As we know, companies cut jobs and move them to India due to the availability of skilled, English-speaking labour for a fraction of the wages paid in the West.

Top executives are highly-motivated to outsource and cut wage costs, more so after a competitor has done the same. Finding cheaper labour is an easy, short-term fix to help cut losses/raise profits, especially at service companies where labour often accounts for a big portion of total costs. Rising profits mean larger bonuses and other big financial gains for top executives, including through generous self-awards of low priced stock options and grants at most publicly traded companies.

Up until the mid-1990s, Indian companies were hired mostly to do tedious work – writing repetitious code for software programs and so on. These jobs were ignored by most IT professionals in the West, since the rates were low and the offices were often white collar sweat shops.

Then, in the late-1990s there was the fear that unless older computer systems were patched up or upgraded, they would crash and cripple vital operations when the date switched to the year 2000 (the Millennium/Y2K bug). The software patches said to be necessary for handling the Y2K problem also mostly involved tedious work that boosted demand for Indian IT services.

In the late-1990s fears over the Y2K problem coincided with the frenzied, euphoric internet bubble. Many IT professionals were walking out of their corporate jobs to join high technology start-up companies. They swapped their suits for jeans and T-shirts to work for a lower salary and at times for no salary. They said they were giving up dead-end, back office jobs for the excitement of the new era of the internet. Few of them openly admitted their real goal was to cash in large sums of money on stock in the initial public offering of their start-up companies.

At least up until early 2000, the odds of IT professionals walking away with millions in a high-flying public offering were far superior to their chances of buying a winning lottery ticket. Numerous top IT executives – including several of Indian origin – enriched themselves through cashing in low-priced stock options. It did not matter that often the companies they ran had no profits, and, in some cases, no revenues.

Rising demand for IT workers

Sharply rising demand for labour during the internet boom and for tackling the Y2K problem led to a big shortage of IT staff in the US in the late-1990s.

Companies lobbied the US administration to increase the number of professional work visas granted each year so as to bring in more foreign IT staff, mostly from India.

US companies also began sending more back office IT tasks, mostly to India, including payroll, record keeping and software development. Some set up their own operations in India to cut out the profits pocketed by local contractors, control quality and protect the security of their work. In this move, they were influenced by the long-running, successful Indian IT operations of companies like Citibank.

The easy money to fund high technology start-ups dried up as the US stock market bubble began to burst in April 2000. The inability to raise capital during the prolonged stock market decline, which lasted till October 2002, the economic recession of 2001-02, the high levels of corporate debt, the closer investor scrutiny following the accounting scandals that bankrupted Enron and other major companies are all factors that pushed companies to cut costs, reduce debt and stem losses/show profits.

The US economy is now dominated by the service sector, with two-thirds of the output coming from service-related businesses. Typically in most service companies, and some manufacturing companies as well, IT spending accounts for a major portion of capital expenditure. So many US companies can cut a sizeable portion of their annual capital costs by reducing their IT departments and moving the work to India.

The expansion of high speed telecommunication links between India and the US, the growth of internet-based communications and the declining costs of computers and communications also vastly aided the outsourcing trend. The falling costs and higher reliability of newer communication systems were especially important to the shifting of less skilled and relatively lower wage telephone call service jobs from the US to India.

Today the jobs moving from the US to India cover a range of professional skills, in addition to IT work and call centres, including debt collection, equity and bond analysis, accounting, filing income taxes, clinical drug research and so on. As Nandan Nilekani, head of a leading Indian IT firm, Infosys Technologies, told the World Economic Forum in January: "Everything that you can send down a wire is up for grabs".

One irony of this trend is that Indian IT professionals in the US are now themselves being hurt by the partial success of the Indian educational system, which originally got them their well-paying jobs there. Many of them are now facing wage cuts and unemployment, as US companies move jobs to India. A few of them have already been forced to go back to India to find jobs, a reverse migration widely covered by the media.

Some of the companies are possibly moving jobs to India to also avoid facing laws, regulations and public scrutiny in the US over the human and environmental impact of their research, development and production activities. This calls for close official monitoring and greater public scrutiny in India of outsourced work in fields like clinical trials for pharmaceutical drugs and in chemical, biological, genetic and similar areas.

US elections

In the heat of current electoral politics in the US, the Democrats are saying that – if elected – they will abolish tax breaks for US companies moving jobs offshore, force call centre staff to identify where they are based and give government contracts to only those companies that retain jobs in the US. Up until recently the Republican administration apparently viewed outsourcing to be a non-issue, expecting the US economy to create two and half million new jobs by election time in November this year.

This figure is very optimistic considering that the administration had also forecast 1.7 million new jobs in 2003 and that the figure for 2004 is double the consensus estimate of even the perennially rosy bunch of economists employed by major US financial institutions.

Then in February George W Bush's economic adviser N Gregory Mankiw caused some more political heartburn for the Republicans. He said that sending some service jobs abroad "is probably a plus for the economy in the long run" as it will make the economy more efficient and free American workers to move up into higher wage jobs. The Democrats are reported to be using Mankiw's statement in a campaign video against the Republicans. And President Bush is now declining to give any specific numbers on new job creations in 2004.

One way US companies may get around political restrictions – if any are imposed – is by slowing/freezing new hires at home and instead opening operations in India and other low wage countries. Chief executives will argue that they are forced to do this to stay competitive and avoid making further jobs cuts in the US. In February, for instance, Tower Automotive, an auto parts supplier, said it was closing a plant with 500 unionised jobs in Wisconsin and moving the operations to Mexico. Tower's chief executive was quoted as explaining that: "The long-term health of the economy" as well as that of jobs in the US depends on the consumer's ability to buy competitively priced goods.

Rough estimates indicate that in recent years 400,000 to 500,000 IT jobs were moved out from the US. Over the next decade, expectations are that about 3.3 million American jobs in business services alone will be sent outside. So the demand for outsourcing work in India will continue to grow as long as it is cost effective and provided a high quality of service is maintained.

But even as demand grows, it appears to be already bumping up against the availability of skilled labour as reflected in questions raised about the quality of service.

In the US today, both in the media and anecdotally, there are already reports of clients getting bad advice and bad service from operations in India. Last year, the US hardware vendor giant Dell closed down its customer service centres in India and reopened them in the US, in a high-profile switch that attracted wide media coverage. Dell, the largest seller of personal computers and laptops in the US, did not disclose any reasons or numbers or state whether the service centres it re-opened in the US were for government sales.

Staff turnover and quality

The issue of quality of service is also raised by the very high staff turnover rates in India, especially at call centres, where annual turnover is said to exceed 50 per cent. High staff turnover is reported even amongst the more established, employee-friendly IT companies, some of whom offer stock options and residential accommodations to entice employees to stay on.

The staff turnover, especially at call centres, is no doubt partly due to employee “burn out” and other job-related stresses. But employees are also leaving to take up jobs with rival employers who offer higher wages. The high turnover indicates that there are more call centre jobs in India than there are good candidates to fill them. High staff turnover must make it increasingly expensive for India-based operations to maintain and improve their quality of service.

This is due to the rising costs of hiring and training and the higher wages needed to attract high-quality employees. This then brings up the issue of the impact of such costs on profit margins, especially for new entrants into the business and for those with limited capital and/or high debts.

As more Western jobs move to India, the constraints of finding the number of required skilled, English-speaking professionals will likely come to the fore.

The number of students graduating each year from India's top English language-based colleges and professional educational institutions is a very small proportion of the millions coming out of colleges in India. So, for instance, a British company moving engineering jobs to India will want to hire only graduates of the Indian Institutes of Technology (IIT) and other top-rated engineering colleges. A similar selection process would be applied when hiring for outsourced jobs in other professional fields.

One side effect of the high wages paid by Indian-based operations catering to Western clients must be a sharp rise in the wage costs of companies competing for this pool of labour to serve the domestic Indian market. This then brings up the issue of whether or not high labour costs and inability to hire the best talent hurts product innovation, productivity, quality, market share and profits of Indian companies serving the Indian market.

There are undoubtedly millions of competent Indians who can potentially enlarge the supply of skilled labour, beyond that produced by the top institutions.

But the additional infrastructure necessary to train these students, from primary school on through to college, does not exist. Setting up such facilities is very costly, involves years of planning and execution, requires hiring good staff, large tuition subsidies and financial aid schemes. So they are unlikely to receive the attention and funding from Indian central and state governments. Private sector efforts in this regard will be constrained by the inability of most middle class families to bear the full cost of such education for their children, without massive subsidies and financial aid.

The growing demand for outsourcing jobs in India is attracting several new entrants into the business, increasing competition and lowering prices. Some Indian companies, for instance, are currently bidding $20 (£11) per programming hour for US software outsourcing contracts, down from over $60 (£33) in 2000.

Increased competition amongst vendors, in addition to labour supply constraints, could compound the decline in quality of service.

This could happen as aggressive, inexperienced new entrants in India price their services low in order to win business from US companies. But after winning a contract, they will face the dilemma of paying high wages to hire good employees or try to cover interest costs, pay down debt and/or make a profit. High levels of debt and desire for quick profits may drive some of them to hire lower cost, less well-trained employees, hurting the quality of their service.

Any incidents of decline in the quality of service in India or even the perception of such a decline will lead to growing criticism from the media and consumers in the US. The resulting backlash, fuelled by the issue of job losses in the US, will be strong and will likely result in some consumers taking their business to competitors. Afraid to lose business, some US companies will then reduce or even shut their operations in India.

Could a withdrawal from India in the near future be as rapid as the speed with which Western companies are currently seeking to get in? The telephone call centre market, where moving to a new geographic location is cheap and easy to do, could be the first to find out.

The history of call centres in the US shows exactly how that has happened in the past.

Call centres there were moved from high-cost urban areas to low-wage, low-rent cities in the mid-west and the south of the US and then to Canada and Ireland and now to India.

In the case of the outsourcing of IT and other professional jobs to India, there may be lessons to learn from the example of Ireland.

US companies set up IT and other operations in Ireland in the late-1980s and early-1990s to take advantage of the English-speaking, lower-cost pool of educated labour. But now there are regular reports of some of these Irish operations closing down. Is this a result of a cyclical bust, following the 1990s boom? Is it due to the rising cost of labour in Ireland? The answers are sure to follow over the course of the year.

There is no doubt that there is a big and growing US demand for skilled Indian labour. The question remains whether or not a limited supply of such labour will lead to a drop in quality of service, which could restrict or even reverse this growth.

Only a handful of companies in India that zealously focus on quality, even at the cost of short-term profit, are likely to be the major beneficiaries of the growth in outsourcing in the long-term.